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How Countrywide Covered the Cracks

ON June 27, 2006, Countrywide Financial, the nation’s largest mortgage lender, was about to close its books on a record-breaking six-month run. The housing market was on fire and Countrywide’s earnings were soaring. Despite all the euphoria inside the company, some executives noticed that Angelo R. Mozilo, the company’s brash and imperious chief executive, seemed subdued.

At a town hall meeting that day with 110 of the company’s highest-ranking executives in Calabasas, Calif., Mr. Mozilo sat alone on a stage, fielding questions and offering rosy predictions about his company’s prospects. But then he struck a sober note in response to a question from one of his colleagues.

The questioner wanted to know what, if anything, worried Mr. Mozilo, according to a participant.

“I wake up every day frightened that something is going to happen to Countrywide,” Mr. Mozilo said.

A year and a half later, that day arrived. In January 2008, Countrywide, the company he had built from a two-man mortgage operation into a lending behemoth, had to sell itself to Bank of America at a bargain price because it was being smothered by losses tied to a mountain of sketchy loans.

Yet almost until the moment Countrywide was taken over, Mr. Mozilo was publicly buoyant about its ability to ride out the mortgage crisis. Privately, however, he occasionally offered a gloomier assessment of Countrywide’s prospects and practices, according to e-mail and interviews.

What Mr. Mozilo, now 71, knew about Countrywide’s problems, and precisely when he knew it, was what eventually led the Securities and Exchange Commission to file civil securities fraud charges against him last year. And on Friday, in the Los Angeles courtroom of John F. Walter, a federal District Court judge, representatives for Mr. Mozilo and for two of his top lieutenants — David Sambol, Countrywide’s former president, and Eric Sieracki, the company’s former chief financial officer — settled those charges.

As part of the settlement, Mr. Mozilo and his co-defendants didn’t admit to any wrongdoing. But Mr. Mozilo agreed to pay $67.5 million in a penalty and reparations to investors and is permanently banned from serving as an officer or a director of a public company. Mr. Sambol is paying $5.52 million in a penalty and reparations and agreed to a three-year ban from serving as an officer or director of a public company. Mr. Sieracki agreed to pay a $130,000 penalty.

The settlement is a signal event in the credit crisis and its aftermath, including the foreclosure debacle that is now rattling the mortgage market and upending the lives of average homeowners. Although Goldman Sachs settled securities fraud charges earlier this year, Mr. Mozilo is the first prominent chief executive to be held personally accountable for questionable business practices that contributed to the housing bubble, the dizzying financial machinations that surrounded it, and a ruinous lending spree that ultimately threatened to undermine the nation’s economy.

Mr. Mozilo and his two former colleagues were accused of misrepresenting the company’s declining lending standards during 2006 and 2007 and portraying themselves publicly as underwriters of high-quality mortgages even as they learned that the company’s loans were becoming increasingly risky.

The government also contended that Mr. Mozilo and Mr. Sambol improperly profited on inside information about the company’s problematic loans when they sold Countrywide shares. From May 2005 to the end of 2007, Mr. Mozilo generated $260 million from his stock sales, while Mr. Sambol’s sales produced $40 million, the government says.

Lawyers for Mr. Mozilo declined to comment. Mr. Sambol’s lawyer said his client had “put the matter behind him for the benefit of his family and loved ones.” Mr. Sieracki’s lawyer noted that the S.E.C. had decided not to pursue fraud charges against his client and that his client had not been barred from serving at a public company. Bank of America is paying Mr. Mozilo’s legal bills. Countrywide is paying $5 million toward Mr. Sambol’s repayment to investors and $20 million of Mr. Mozilo’s reparations.

The S.E.C.’s legal team, led by John M. McCoy III, associate regional director of the enforcement division, said the settlement amounted to a hard-won victory.

In a statement on Friday, Mr. McCoy said: “This settlement will provide affected shareholders significant financial relief, and reinforces the message that corporate officers have a personal responsibility to provide investors with an accurate and complete picture of known risks and uncertainties facing a company.”

Battered by widespread criticism that it failed to corral scam artists like Bernard L. Madoff and to effectively police Wall Street as a whole during the years leading up to the credit crisis, the S.E.C. may now regain some stature as a successful litigator and investor advocate from its settlement with Mr. Mozilo.

“As is the case with most settlements, this is a compromise where nobody comes out a complete winner,” said Lewis D. Lowenfels, an authority on securities law at Tolins & Lowenfels. “The S.E.C. gets a substantial monetary settlement and a bar with respect to Mozilo serving as an officer or director. On Mozilo’s side, he is probably satisfied to have this behind him. He suffers a considerable stain on his reputation, has to pay a substantial amount of money but retains significant wealth and at the age of 71 may find the possibility of being an officer or director of another public company less enticing.”

COUNTRYWIDE FINANCIAL began operations in 1969, when Mr. Mozilo and his mentor, David Loeb, refugees from an established mortgage lender, decided to start their own loan originator. The company grew slowly at first, but by 2004, Countrywide was the nation’s largest home lender, generating annual revenue of $8.6 billion. Mr. Mozilo ran the company alone after Mr. Loeb retired in 2000. (Mr. Loeb died in 2003.)

Photo

Angelo R. Mozilo in March 2008, when he testified before the House Committee on Oversight and Government Reform.Credit
Kevin Lamarque/Reuters

An up-by-the-bootstraps entrepreneur — his father was a butcher in the Bronx — Mr. Mozilo was obsessed with wresting market share away from his buttoned-down rivals in the staid world of banking.

“I run into these guys on Wall Street all the time who think they’re something special because they went to Ivy League schools,” he told The New York Times in 2005. “We’re always underestimated. And we still are. I am. I must say, it bothered me when I was younger — their snobbery and their looking down on us.”

In an industry that favored low-key behavior and conservative dress, Mr. Mozilo stood apart. He offered blunt opinions about banking and was open about his corporate aspirations. To complement his ever-present tan, he wore flashy clothes and drove expensive cars like Rolls-Royces that were often painted in a shade of gold.

Still, he managed his business for most of its history with a tight focus on the bottom line and on vigilant lending practices.

For years, Countrywide specialized in plain-vanilla, fixed-rate loans. As recently as 2003, such mortgages accounted for 95 percent of the company’s loans, according to regulatory filings. Countrywide was the biggest supplier of mortgage loans to Fannie Mae, the federally backed mortgage finance giant that was also hobbled in the credit crisis.

In 2004, Countrywide’s sober-minded lending style changed significantly. It began aggressively offering loans to first-time home buyers and to borrowers with modest incomes. These mortgages were known in the industry as “affordability products,” but that ho-hum designation belied the potential financial dangers embedded in the loans if borrowers — particularly low-income borrowers — wound up unable to pay their debts.

Even so, Countrywide embraced such loans with gusto. For example, adjustable-rate mortgages — those with a low introductory rate that could ratchet up in later years — accounted for about 18 percent of Countrywide’s business in 2003. But a year later, they made up 49 percent of its loans.

Subprime loans also grew in 2004, to 11 percent of its originations, up from 4.6 percent in 2003. These loans often required no down payments and very little documentation of borrowers’ incomes, assets or employment; they generated immense profits to Countrywide but, again, presented a bevy of risks. And even when the going got rough for some homeowners, Countrywide didn’t hesitate to take a hard line with borrowers who fell behind.

A born salesman, Mr. Mozilo promoted his company’s prospects wherever he went. In front of a crowd of investors or analysts, he would predict what Countrywide would generate in profits five years down the road and how many of its competitors the company would vanquish. No matter what, Countrywide would survive, he vowed.

“Over the entire history of this country, housing prices have never gone down nationally. They have gone down in some local areas, but never nationally,” he told an interviewer for CNBC in early 2005. “Secondly, any homeownership over the 10 years has proved to be the best investment that you could ever make. Over any 10-year period, housing prices go up.”

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Later that year, he was equally optimistic when he again visited CNBC’s studios.

“From our perspective — and we’ve been doing this for 38 years — we’re still in a terrific mortgage market,” he said. “So the road ahead to us appears to be extremely vibrant, very sound.”

Even as the wheels were coming off of the Countrywide cart in 2007, Mr. Mozilo’s upbeat public pronouncements continued.

“I think you have to keep things in perspective. You know, there’s an old saying that you don’t know who’s swimming naked until the tide goes out, and obviously the tide’s gone out,” he told CNBC in March 2007, when a number of once-successful subprime lenders were plunging toward bankruptcy. “I think it’s a mistake to apply what’s happening to them to the more diversified financial services companies such as Countrywide.”

When Bank of America invested $2 billion in Countrywide in August 2007 — a move that caused many analysts to question Countrywide’s financial wherewithal and its ability to remain independent — Mr. Mozilo again struck an optimistic note.

“Countrywide’s future’s going to be great. You know, it’s always been great,” he told CNBC at the time. “So I think, down the line, this is going to be a better company, a more profitable company and a company that’s going to be a great investment for shareholders as we continue down the line. Because the market ultimately will come to us. This is America. People want to own homes.”

PRIVATELY, however, Mr. Mozilo had long been worried about some of the loans his company favored, as indicated by e-mails he sent to his deputies. And this gulf between Mr. Mozilo’s private views and his public proclamations went to the heart of the S.E.C.’s case against him.

Beginning in 2005, for example, he fretted about lending practices at Countrywide, e-mail messages show. One target of his ire was the “pay-option adjustable-rate mortgage,” a loan that let borrowers pay a fraction of the interest owed and none of the principal during an introductory period. These loans put homes within many borrowers’ financial grasp — at least initially.

When a borrower made only modest payments, the shortfall was added to the principal balance on the loan, meaning that the mortgage would grow in size. Given this arithmetic, borrowers could wind up owing more than their homes were worth.

In 2004, pay-option A.R.M.’s accounted for 6 percent of Countrywide’s originations. Two years later, they accounted for 21 percent of its loans. The loans were moneymakers for Countrywide; internal company documents show that the company made gross profit margins of more than 4 percent on such loans, double the 2 percent generated on standard loans backed by the Federal Housing Administration.

Countrywide pushed the lucrative loans hard. A sales document called “Pay Option A.R.M.’s Made Simple” asked rhetorically what kinds of customers would be interested in these loans. “Anyone who wants the lowest possible payment!” was one of the answers.

But these loans unnerved Mr. Mozilo, as his e-mails indicate. In April 2006, for example, he learned that almost three-quarters of the company’s pay-option customers had chosen to make the minimum payment the prior February, up from 60 percent the previous August, according to the S.E.C.’s complaint. In an e-mail to Mr. Sambol, Mr. Mozilo wrote: “Since over 70 percent have opted to make the lower payment it appears that it is just a matter of time that we will be faced with much higher resets and therefore much higher delinquencies.”

Two months later, and just one day after he talked up his company’s pay-option A.R.M.’s to investors at a Wall Street conference, Mr. Mozilo wrote an e-mail to Mr. Sambol predicting trouble ahead for many borrowers in these mortgages. They “are going to experience a payment shock which is going to be difficult if not impossible for them to manage,” he said.

And in September 2006, Mr. Mozilo wrote an e-mail saying the company had no way to assess the risks of holding pay-option A.R.M.’s on its balance sheet. “The bottom line is that we are flying blind on how these loans will perform in a stressed environment of higher unemployment, reduced values and slowing home sales,” he wrote.

Another Countrywide product that concerned Mr. Mozilo was its so-called 80/20 loan, named for the fact that the combination allowed a borrower to receive money covering 100 percent of a home’s purchase price.

Mr. Mozilo had become worried about these loans in the first quarter of 2006, when HSBC Bank, a buyer of Countrywide’s 80-20 loans, began forcing the lender to repurchase some that HSBC contended were defective.

“In all my years in the business, I have never seen a more toxic product,” he wrote to Mr. Sambol in an April 17, 2006, e-mail cited by the S.E.C. “With real estate values coming down ... the product will become increasingly worse.”

Such e-mails suggest that by mid-2006, Mr. Mozilo had recognized how reckless some of his company’s lending had become. And just three months later, according to the S.E.C. complaint, he met with his financial adviser to increase the amount of Countrywide shares he could cash in under a planned executive stock-sale program.

Mr. Mozilo had always been a big seller, and rarely a buyer, of the Countrywide shares he was granted as a part of his compensation. The timing of some of his sales, however, has drawn the scrutiny of the S.E.C.

For example, on Sept. 25, a day before writing the e-mail about how Countrywide was “flying blind” on pay-option A.R.M.’s, he set up a new planned stock-selling program for himself, known as a 10b-5 plan, the S.E.C. said.

Such plans allow executives to sell stock regularly, without running afoul of regulations governing the sale of stock around significant corporate announcements. Mr. Mozilo also set up plans enabling a family foundation and a trust he oversaw to sell shares.

Altogether, the S.E.C. said, from November 2006 to October 2007, he sold more than five million Countrywide shares under his personal plan. His gains were $140 million, the S.E.C. said.

Mr. Mozilo has long maintained that his stock sales were not unusual, and in the past Countrywide has said that it and Mr. Mozilo were battered by economic forces beyond their control.

“No one, including Mr. Mozilo, could have foreseen the unprecedented combination of events that led to the problems borrowers, lenders and investors face with many of these loans today,” a Countrywide spokesman told The Times in 2007. “Countrywide is proud of its role in making homeownership affordable to lower-income households.”

But lawyers and analysts say Friday’s settlement means that Mr. Mozilo’s legacy is likely to be something quite different from that of a banker who brought homeownership to the masses.

“Mozilo is agreeing to a permanent ban on serving as an officer or director of a public company,” said James A. Fanto, a professor at Brooklyn Law School and a specialist in corporate and securities law. “That is a significant punishment and does not look good for his legacy.”

A version of this article appears in print on October 17, 2010, on Page BU1 of the New York edition with the headline: How Countrywide Covered the Cracks. Order Reprints|Today's Paper|Subscribe